Why Real Estate?
FIRECM sees real estate as the best long term investment to create and store wealth due to the ability to leverage other peoples money (banks) without the risk of margin calls, favorable tax laws, its tangible nature allowing for owners to control their investment unlike stock ownership, strong cash flow characteristics, favorable supply/demand dynamics, and inflationary hedging characteristics.
Mr. Berkley began investing in real estate after beginning to understand its power to create wealth while reading about central and commercial banking. In the absence of hard money (i.e. a gold or similar standard), a country’s currency will always be devalued over time by its central bank / government and lose value, causing the prices of all goods and services to rise in the long run. Occasionally, innovation can outpace inflationary pressure as seen with the price of computers and televisions over the last few decades, but for goods lacking ability to be improved (a can of cola or cheeseburger, the cost of lumber and steel, etc.), prices rise.
The lack of a sound money system is driven by human nature and the desire for societies to collectively have their cake and eat it too. Societies want government paid healthcare and student loan forgiveness and many other benefits, but don’t want to pay the taxes to fund them.
Governments also eventually act in inefficient ways or spend more money than they can produce via taxes on wars and other expenditures. When this happens, the path of least resistance is to print money to pay off debts vs. cutting social programs or raising taxes, thereby increasing the money supply and devaluing the currency. Real estate benefits from printing money (more recently called monetizing debt or quantitative easing), far more than equities, which many view as an inflationary hedge, thanks to the ability to purchase real estate using fixed rate debt.
For simplicities sake, let’s assume inflation across an economy is 10% and therefore rents and building values rise 10%. Using a $1 million dollar asset, an investor owning that asset in cash earns a 10% nominal return or $100,000 and a 0% real return as his/her buying power is unchanged as everything in the economy has risen 10% in price. A 10% return minus a 10% loss in purchasing power from inflation, yields 0% wealth creation for the investor. At least the investor didn’t sit in cash and take a 10% loss though.
However, an investor that takes $1 million cash and borrows $3 million more to buy a $4 million property, will earn a 40% nominal or 30% real return thanks to the use of bank debt. When banks lend, they don’t require profit to be shared with them on their ownership of the underlying asset that they are lending on. Banks only seek to collect a fixed rate of interest on the money that the lend out. Sticking with this example, a 10% rise in value on a $4 million property equates to $400,000 of profit or a 40% gain. The cost of everything has risen 10%, so this investor earned a 40%-10% = 30% real return.
The use of debt to fund real estate purchases is far less risky than stock purchases. When stock prices fall and an investor owns them using debt, his/her broker will demand he/she put more cash in their account to cover any losses and prove he/she can pay back what was borrowed. Banks don’t have margin calls and the monthly debt payment is fixed. When property values drop, it only matters that there is enough cash flow generated by the asset to pay the monthly debt payment.
Since Mr. Berkley and FIRECM do not expect human nature to change or the United States to go back to hard money anytime soon, or the central bank to disappear, he decided to invest heavily in real estate a decade ago and continues to do so with a focus on the long term and passive income generation. He invites others to join him in the preservation and creation of wealth.
For more details on FIRECM’s specific approach to real estate investing see the home page and individual fund pages.